But that doesn't help wealthier investors who have already maxed out their retirement contributions.
They'd be wise to rely on ETFs that track broad indexes. Because of the way ETFs are structured and traded, the fund doesn’t have to sell assets to raise cash to meet redemptions, which means investors don't have to worry about tax hits caused by others heading for the exit. ETFs have long been touted for their tax efficiency, but today's environment makes them even more so.
Many people are attracted to target-date funds because they can just set them up and forget about them; the fund does all the rebalancing automatically as their retirement date nears. That may be true, but if you're tax sensitive, and given the likelihood for big capital gains distributions, why not just buy a few different ETFs and diversify your portfolio yourself? Or if you have considerable assets, pay a financial adviser to do so.
If you're still intent on investing in a target-date fund or another mutual fund outside your 401(k), then look for those that say they are tax-managed or tax-efficient. Generally if one of those phrases is in the title of the fund, it means that managers will try to keep distributions, and hence, taxes, to a minimum. Check the fund's prospectus to be sure.
But you should know, there's only so much a mutual fund manager can do if there's an onslaught of redemptions, so even tax-managed funds could eventually have to make distributions, says Mark Wilson, a certified financial planner in Irvine, California.
For anyone who is currently invested in a fund that made a big distribution last year, proceed with caution. If you've held the fund for a while, selling now would be foolish since you're likely to incur capital gains of your own making. You may be in the driver's seat, but the tax pain could be a lot worse.
Alexis Leondis is a Bloomberg Opinion columnist covering personal finance. Previously, she oversaw tax coverage for Bloomberg News.